Ascertainment of Profit/Loss on Contract
The Profit/Loss on contract is ascertained as follows:
a) On completion of Contract:
The excesses of credit over the debit items of the contract a/c is the profit, and the whole of it can be taken into account. The excess of debit over the credit items is loss.
b) On incomplete Contract:
Where a contract takes more one financial year for in to complete, it is usual to take into account a part of the profit only to the Profit and Loss Account. If there is a loss, the whole of the loss is transferred to the P & L A/c.
What part of the notional profit should be credited to the profit and loss account each year, depends on the practice and circumstances of the case. The general rules are:
a) If the value of certified work is less than 1/4th of the contract price, no profit is taken into account, and the balance of the contract a/c is transferred to the Work-in-Progress A/c.
b) If the certified work is 1/4th or more than 1/4th, but less then ½ of the contract price, only 1/3 of the computed profit as reduced to the cash basis (cash received on work certified), should be credited to the Profit and Loss Account. The formula is:
Profit = Computed profit, i.e. Cr. Balance of contract a/c x 1/3 x (cash received / work certified)
The balance of the computed profit is a reserve and is transferred to Work-in-Progress A/c.
c) If the value of certified work is ½ or more than ½ of the contract value, 2/3 of the computed profit as reduced to the cash basis is credited to P & L A/c.